Suppose BiscuitCo has a biscuit factory capable of producing 1,000 packs of biscuits a day. If it produces only 10 packs a day, it has to buy only enough biscuit ingredients to produce 10 packs a day at a cost of £1 per pack. The ingredients are a variable cost of production - the cost varies with the amount produced.

The factory, on the other hand, is a fixed cost. Regardless of whether BiscuitCo is making one pack a day or 1,000, the cost of the factory is fixed at £1,000 per day.

If BiscuitCo produces 10 packs a day, the total cost is £1,000 for the factory plus £10 for the ingredients, or a whopping £110 per pack. If, however, it makes 1,000 packs a day, the total cost is £1,000 for the factory plus £1000 for the ingredients. The cost is now only £2 per pack.